Markets will see if the recent strong data out of the US translates into higher price pressures on Tuesday. This has sharply reduced the bets on early rate cuts. But inflation rates are diverging and this underscores the bumpy path back to the Fed’s 2% target.
The central bank’s favoured gauge, the personal consumption expenditures (PCE) price index, most recently printed in line with economists' expectations and translated to an annualised pace in keeping with the Fed’s inflation goal. Indeed, on a three-month and six-month annualised basis, underlying core PCE inflation is running below target while the increase from a year ago was 2.9%, the smallest rise since March 2021.
CPI and Fed's preferred price measure diverge
CPI has been posting more rapid month-on-month increases than the Fed’s favoured inflation gauge, the core PCE deflator. This is largely due to the heaving weighting of housing and vehicles in the basket of goods and services used to calculate the consumer inflation rate. Rents are slowing, but the way the series is constructed within the CPI report means those movements take a long time to show up in official data. Used vehicle prices could also be a depressing factor on January inflation.
The consensus view looks for headline CPI to rise +0.2% M/M and 2.9% y/y in January (prev. +0.2% and 3.4%), and the core CPI measure is seen rising +0.3% M/M and 5% y/y, matching the monthly rate seen in December and one-tenth lower y/y.
As always, the data will be framed in the context of the Fed's policy function, where markets see lower inflation readings as a sign that the central bank could begin cutting rates, while any pickup in price pressures would see a wager on the 'higher for longer' playbook.
Recent US data has been surprisingly strong
Whether CPI follows recent data which has consistently surprised to the upside is a key question. The blowout January jobs report indicated that wage growth picked up to 4.5% after showing signs of cooling. The monthly increase was more than double estimates and corresponds to a 7% annual increase.
Markets have responded to the stream of positive reports, with Treasury yields rising close to the year-to-date top while the dollar recently hit multi-week highs. Another tick up in inflation will further boost this rally and dent the chance of a May rate cut which is currently just above a coin toss.